Italian contagion goes global on snap election fears

John Hardy

Head of FX Strategy, Saxo Bank Group
John Hardy joined Saxo in 2002 and has been Head of FX Strategy since October 2007. He focuses on delivering strategies and analyses in the currency market as defined by fundamentals, changes in macroeconomic themes, and technical developments.

It appeared yesterday that we had reached some sort of brief peak in uncertainty on the situation in Italy after Italian 10-year spreads to Germany stretched as wide as 322 basis points before contracting back to 252 bps. But then it emerged later in the day that newly appointed caretaker Italian PM Cottarelli was unable to form an acceptable cabinet and if fails to do so soon, this could set Italy on course for snap elections as soon as July, which perhaps raises the odds that the populist vote is strengthened as the heat of the situation has less time to fade in favour of a sober analysis of the implications of Italy finding itself unable to fund itself in euros.

Cottarelli will meet with Italian president Mattarella today and there will likely be some announcement from that meeting. 

The second wave of panic late yesterday saw EURCHF trading below 1.1400 briefly and contagion from the Italian issue has clearly generated a sufficiently large shockwave now to act to as a source of global systemic contagion. The S&P 500 index finally awoke from its torpor and closed below a pivotal local support level and Asian markets were also in for an ugly session overnight.

In Europe, EURHUF closed yesterday at the highest level since the one-off surges around the early 2015 CHF reval and the day of Brexit. Most of the HUF weakness is likely linked to the general EU existential threat, but could also be down to the recent EU budgeting process, where it has emerged that CEE countries face heavy drops in their funding levels, with a large funding increase set for southern Europe, including Greece and Italy.

It is inconvenient for Italy at the moment that fresh BTP auctions (Italian sovereign debt) are on the calendar. Yesterday’s auction of six-month Italian paper drew weak bids and was barely covered (bid to cover at 1.19) with a yield of +1.2% after the prior auction saw a bid to cover of 1.65 with a yield of -0.42%. Today sees the auction of some EUR 5 billion in 5-year, 7-year  and 10-year BTPs at 09:00 GMT and will be closely watched for demand levels.

Today will be another tense affair and we suspect that some sort of rhetorical “intervention” from the European Central Bank, or more important, from the EU political elite is arising risk and could generate vicious two-way volatility as is always the case when liquidity is weak. The elite needs to think about the risk to EU banks from this episode; the EuroStoxx bank index has down almost 5% yesterday and has collapsed almost 15% since earlier this month. On the other hand, if the elite’s attitude is to let the Italian populists eat cake, the situation could continue to spiral uncomfortably before the collateral damage becomes too great to ignore.

If the market can tear its eyes away from the situation in Europe for any length of time (rather doubtful), we do have a Bank of Canada meeting on tap for today as USDCAD is champing at the bit above the 1.3000 level on the recent breakdown in oil prices and ready for more if the BoC signals the all clear with further signs of caution on any immediate need to hike rates. The risk-off contagion from Italy, weaker oil prices and more Trump protectionist noise of late encourage the CAD bears for a run above 1.3100 into new highs not seen since early 2017.

Chart: EURUSD weekly 

EURUSD has ground lower into a key support zone, not so much the prior cycle low around 1.1550, but more the entire range defined once the early 2015 lows were reached until the zone was broken last summer, with the pivot area in the 1.1450-1.1500 zone. Any sustained dip below that zone and we have to talk about the rejection of the entire EURUSD rally sequence

The G-10 rundown

USD – the greenback is a safe-haven of a lesser carat that the JPY, but broadly strong and likely to remain so as long as risk-off contagion is afoot. The temperature level rises further for global assets if the S&P 500 200-day moving average, never really broken after multiple attempts since early February, gives way (it is much higher than it was back then now as well – only a couple of percentage points from yesterday’s low.)

EUR – the EURUSD nearing a critical zone as we outline above. The Italian BTP auction and the outcome of the Cottarelli/Mattarella meeting the key headline generators on the day, as well as any possible turns from key EU figures (how Juncker finger-wagging can create anything constructive here is beyond me, but let’s see).

JPY- EURJPY executing a  perfect test of the weekly Ichimoku cloud support around 124.62 yesterday and any worsening of the existential threat in Europe could continue to drive the action lower there as EURJPY offers the highest beta to euro exposure.
GBP – sterling barely mustering a rally against the struggling euro speaks volume as the currency is no safe-haven here. 

CHF – EURCHF acting as a second fiddle proxy for EU existential strain relatively to EURJPY, with the SNB likely acting to keep things orderly. Note that SNB governor Jordan is out speaking later today. 

AUD – AUD struggling below 0.7500 in early trading today, but with focus elsewhere, there is little energy here. That could change if risk aversion switches into a higher gear and AUDUSD is staring down the lows for the cycle again.

CAD – more energy in CAD crosses today on the BoC guidance today, which we see as most likely cautious (some degree of caution already priced in) and with the 1.3000 level the tactical pivot.

NZD – nothing nefarious for the kiwi in the RBNZ financial stability report released overnight or in RBNZ governor Orr’s comments. 

SEK – existential pain for the EU is no friend to SEK, but we still look for opportunities to fade EURSEK upside ahead of 10.50 on valuation.

NOK – the krone is cheap, but has been out of favour on weak risk appetite and the correction in oil prices. Hard to see any pronounced rally in EURNOK from these levels as we prefer to keep our eye out for bearish reversals.

Upcoming Economic Calendar Highlights (all times GMT)

   • 0900 – Italy BTP auctions (EUR 6 billion)
   • 0700 – Spain May CPI
   • 0730 – Sweden Q1 GDP
   • 0755 – Germany May Unemployment Change /Rate
   • 0800 – Poland May CPI
   • 0900 – Euro zone May Confidence Surveys
   • 1215 – US May ADP Employment Change
   • 1230 – Canada Q1 Current Account Balance
   • 1230 – US Q1 GDP Revision
   • 1400 – Canada Bank of Canada Rate Decision
   • 1445 – Switzerland SNB’s Jordan to Speak
   • 1800 – US Fed Beige Book


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